Popular Science Monthly/Volume 29/May 1886/The Difficulties of Railroad Regulation
By ARTHUR T. HADLEY.
Any practical scheme of railroad control is likely to be based upon a compromise. The different interests involved are so conflicting that it will not do to attempt a solution from any one standpoint exclusively. The direction which legislation is to take can not be decided by a mere consideration of complaints against the existing system, whether well-grounded or otherwise. We must also consider what other systems have been tried, and what evils they have involved; what lines of treatment have been undertaken, and how far it has been found possible to carry them out. It is not a question what we would like to do, so much as what we actually can do.
The community requires four things of its railroad system:
1. That it shall afford sufficient facilities to meet the wants of business. In other words, there must be enterprise in building new lines, and in keeping the old ones up to a high standard of efficiency.
2. That the charges, as a whole, shall be as reasonable as possible. If they are higher than those of other countries, or higher than is necessary for the support of the railroads, the business development of the community will be retarded.
3. That there shall not be arbitrary differences in charge which force business into unnatural and wasteful channels, or cripple one man for the enrichment of another.
4. That there shall be as little waste of capital as possible, either by corruption, extravagance, or want of business skill. This is not quite so vital a matter as the other three, but it is one which we can not afford to leave out of account.
No system of regulation is ever likely to be devised which shall secure all these results. Free competition, as we have tried it in America, produces rapid construction and low rates, but fosters discrimination and extravagance; thus securing the first and second requirements, at the sacrifice of the third and fourth. The French system of regulated monopoly has just the opposite effect; it prevents waste and discrimination, but development is slow and rates are high. The third and fourth requirements are secured at the expense of the first and second. England enjoys the first and fourth advantages, at the sacrifice of the second and third; Italy has secured the second and third, but failed of the first and fourth. The Granger system of regulation sacrificed the first in the effort to secure the second. Partial state ownership, as we shall see, secures nothing at all; exclusive state ownership secures the third, at great risk of sacrificing all the others.
The different requirements are to a certain extent in conflict with one another. This conflict can only be understood by studying the history of railroads, and the principles which underlie railroad business management. These are quite imperfectly known at present. There is probably no subject of equal importance on which public enlightenment is so much needed. The capital invested in the railroads of our country is eight times that of its banking institutions; the tonnage carried by rail is four times that carried by water; the abuses in internal commerce come home to most of us far more directly than those in foreign commerce. Yet, for every man who has studied the political economy of railroads, there are a dozen who have studied that of shipping and foreign trade, and a hundred who have studied that of banking. The complications of the subject are hardly recognized. Railroad reformers are far too ready to blindly pursue one specific object or combat one specific abuse, regardless what other objects may be sacrificed, or what other abuses fostered by their policy.
From 1830 to 1873 the main object of nearly every community was to secure rapid development of railroad facilities — the first of the four requirements we have named. The railroad proved so much superior to other modes of transportation, that the country which had railroads prospered; that which had not railroads fell behind. Legislation was everywhere devised to favor this end. Where capital was ready to invest, every encouragement was offered it. If the removal of obstacles was not enough, a subsidy was generally to be had for the asking. If the community could not afford to pay a subsidy outright, it guaranteed a certain income to the road. If all these inducements were insufficient, the state stepped in and built the road itself. In England, where there was plenty of capital seeking investment, railroads were chartered literally by hundreds. In America they were not only exempted from the necessity of securing special charters, but received municipal aid, as well as grants of public land on a scale which was often outrageous. In France the state paid half the cost of building the road, and offered the companies monopoly privileges as an inducement for supplying the other half. Belgium built the main lines of road at state expense for state management; but at the same time the building of private lines was also encouraged in every possible way. It was not until too late that men saw what chances for waste and corruption were involved in this indiscriminate encouragement of railroad construction. England learned the lesson in 1847; Continental Europe in 1873. In spite of the severe experiences of 1857, 1873, and 1884, it is by no means certain that America has learned it even yet.
For a long time the only fear was that railroad charges would be too high; and this fear was happily disappointed. The maximum rates which were fixed in the earliest charters were useless, simply because the railroads generally adopted a lower scale of their own accord. It was found that the profits depended quite as much upon the volume of business as upon the absolute rates charged, and that it was often better to do a large business at low rates than a smaller business at higher rates. This is of course true to some extent in every department of industry, but there are reasons which make it apply specially to railroads. About half the expenses of a railroad are to a considerable extent independent of the amount of work done. Thus an increase in the volume of traffic does not produce a corresponding increase in cost.
Railroad expenses may be roughly divided into two classes, according as they do or do not vary with the amount of business done. Those which do not vary rapidly are called fixed charges. This includes interest on cost of construction, the general expenses of the organization as a whole, and a considerable part of the expense of maintenance, which is due to weather rather than to wear. Those expenses which vary nearly in proportion to the amount of business done are called operating expenses. Under this head are included the different items of train and station service, with some others. The fixed charges of the railroads of the United States average somewhat over $2,500 per mile annually; the operating expenses average from forty to sixty cents per train-mile.
In order that a railroad as a whole may be profitable, it is necessary that it should earn money enough to pay fixed charges as well as operating expenses. But, in order to secure any individual piece of business, it can afford to make rates which shall little more than cover operating expenses, provided such business can be had on no other terms. To secure traffic which it could not otherwise have, a railroad can afford to make rates which would bankrupt it if applied to its whole business.
Such was the origin of discriminations. Sure of a certain amount of traffic at high rates, which would contribute its full share to the payment of fixed charges, each railroad strove to secure additional traffic at lower rates which would little more than pay operating expenses. This reduction was first made in favor of articles of low value, like coal, stone, or lumber, which could not be moved at all at high rates, but which could furnish a large business at low rates. Here it was an unmixed benefit to the public. The reduction was next applied in favor of long-distance traffic; and here also it was a good thing in principle, though sometimes overdone in practice. Under the old system of equal mileage rates, where the charge was made proportional to the distance, it would have cost something like a dollar a bushel to get wheat from the Mississippi Valley to the seaboard; a price which would have been simply prohibitory to the growth of the Western States.
There were special circumstances which led the railroads to give the long-distance traffic more than its due share of favor. A great deal of this traffic had the benefit of competition, either between several lines of railroad, or between rail and water routes. The reductions in rates were made most rapidly where such competition was most active—that is, at the large cities. The result was a system which favored cities at the expense of the country—by no means a good thing. But this was not the worst. In any period of active railroad competition large shippers were almost always given lower rates than small shippers. Amid the constant variation of rates, unscrupulous men gained advantages at the expense of more honorable men. Secret favors were generally given to those who least needed or least deserved them. The railroad agents forgot their obligations to the public as common carriers. Too often they were ready to sacrifice even the permanent interests of the stockholders themselves in the lawless struggle for competitive business.
It must not be forgotten that railroad competition did some things for the country which nothing else could possibly have done. It taught our railroad men to handle a large business cheaply. It taught them to make money at rates which would have seemed suicidal to the easy-going managers who were not under any such stimulus. The rapid reductions of charge, in other countries as well as America, have been made in the stress of railroad wars. But, while railroad competition has been in some respects a beneficent force, it can not be trusted to act unchecked. To the business community regularity and publicity of rates are more important than mere average cheapness. Business can adjust itself to high rates easier than to fluctuating ones. And railroad competition of necessity makes rates fluctuate. It tends to bring them down to the level of operating expenses, regardless of fixed charges. If it acts everywhere, as in the case of the New York Central and West Shore, it leaves little or nothing to pay fixed charges, and means ruin to the investor, followed by consolidation. If it acts at some points and not at others, those points which have the benefit of competition have rates based on operating expenses, while the less fortunate points pay the fixed charges. Then we have discrimination in a dangerous form.
As long as competition exists, there is no escape from this alternative. If it exists at all points, it means ruin; if it exists at some points, it means discrimination. The efforts to prevent these results by law while retaining the principle of competition, only show how powerless we really are in this matter. Let us look at them in order.
The first legislators tried to treat the railroad as a public highway, over which any man should be at liberty to run cars, as he can run boats over a canal or wagons over a turnpike. This idea was incorporated in the railroad charters of England and Prussia. It has never been quite abandoned by theorists; but practically it has proved a failure wherever tried. Physically it is impossible, on account of the danger of collision; industrially it is impossible, on account of the added expense. Nobody would build a railroad on such terms unless the mere tolls for the use of the track were to be made higher than the whole transportation charge now is.
A second plan for making competition a public benefit has been that of state ownership of part of the competing lines. It has been tried on a large scale in Belgium and Prussia, and on a smaller scale in most other countries, the United States not excepted. It was thought by the advocates of the system that the government would thus obtain a controlling influence over the railroads with which it came in contact, and be able to regulate their policy by its example. These hopes have been disappointed. The private railroads under such circumstances regulate those of the government far more than the government regulates the private railroads. There is no chance to carry out any schemes of far-sighted policy. If the private roads are run to make money, the government roads must be managed with the same end in view. The tax-payers will not let the government lines show a deficit while competing private lines pay dividends. No administration would dare to allow such a thing, however important the end to be attained. As a matter of fact the government roads of Belgium and Germany were as ready to give rebates as the private lines with which they came into competition. In Belgium they went so far as to grant special rates to those persons who would agree not to ship by canal under any circumstances. The same thing has been done in New York State; but in Belgium the peculiar thing was that the canals and railroads both belonged to the government, and yet were fighting one another in this way. The system of partial state ownership was hardly distinguishable in its effects from simple private ownership. This fact has been clearly recognized within the last twelve years. Within this period, Belgium, Prussia, and Italy have abandoned the "mixed system." Belgium and Prussia have made state management all but universal; Italy has practically given it up.
Of much more importance in the United States has been the effort to regulate charges by legislation, without touching the question of ownership. There was no lack of authority for so doing. Common carriers had been made the subject of special regulation from time immemorial, and it was a well-accepted principle that their charges must be reasonable.
But what constitutes a reasonable charge? On what basis are we to compute it?
It is by no means a sufficient answer to say that rates should be based upon cost of service. What items of cost shall we include? Shall we count the fixed charges, or simply consider operating expenses? In the earliest legislation the former course was adopted. The English tolls and maxima were calculated upon this basis. But they were soon found to be so high as to be almost inoperative. At any rate, they did not prevent discrimination. They allowed the railroad to earn its fixed charges where it chose, and to lower rates elsewhere. A prescribed rate of this kind is too high to be of any use.
On the other hand, to prescribe a rate which does not provide for fixed charges is even worse. This was tried in the Mississippi Valley in the Granger movement. It was argued by the farmers that, if the railroads could afford to carry their competitive traffic at very low rates, they could afford to do the same for the local traffic. All rates were therefore reduced by law to the basis of the competitive ones. What was the result? In Wisconsin, where the system was carried out most completely, a law of this kind was in operation for two years. At the end of that time, not a single railroad was paying dividends; only four were paying interest on their bonds. Railroad construction was at a stand-still. The existing roads could not afford to extend their facilities for traffic. The development of the State was checked—checked so abruptly that the very men who were most clamorous for the railroad law in 1874 were most clamorous for its repeal in 1876. In their anxiety to secure low rates, they had overlooked the necessity for railroad development. This oversight reacted forcibly against them; and the same reaction is likely to be felt wherever reckless railroad legislation is attempted. Our railroad profits are not so high as is often supposed. They are less than four per cent on the nominal capital; and, making all due allowance for water, probably less than six per cent on the actual investment. Admit, if you please, that the corruption of inside rings absorbs an additional amount which ought to go to the investor; this does not affect the fact that, if your legislation prevents the investor from receiving his dividends, he will not invest his capital in your State. It is not now a question of ethics as to what you or he ought to do; it is a matter of fact, proved by actual experience as to what he will do.
Fortunately, no other State had quite so severe an experience as Wisconsin. There were somewhat similar laws in other States, for instance, in Illinois; but the enforcement of the Illinois law was intrusted to a commission. The commissioners were not men of experience in these matters, but they had the sense to see that the attempt to reduce rates too sharply would defeat the purposes in view. They therefore used their powers with some discretion; not attempting to reduce rates everywhere at once, but simply to correct the worst abuses. They were not altogether successful, but they made no such disastrous failure as occurred in Wisconsin.
There is an undeniable advantage in entrusting the execution of such a law to the somewhat discretionary power of a commission. A court is not well qualified to enforce a hard and fast law concerning railroad rates. The courts are compelled to rely somewhat blindly upon precedent; while railroad management is so new a thing that the precedents derived from other lines of business are often misleading. The best proof of the usefulness of railroad commissions is the extent to which they have prevailed. Nearly two thirds of our States have them; there is scarcely a serious attempt at railroad regulation in the United States except through some such agency.
But, even in the best hands, the power to fix rates is of somewhat doubtful utility. More effective statutes have been aimed at discrimination itself not to fix the rate, but to limit the chance for arbitrary differences. In one sense it ought hardly to need a statute to do this. Secret rebates and personal discriminations are so clearly against the spirit of the law of common carriers, that to call public attention authoritatively to these things is to condemn them. The work of the Hepburn Committee in New York, in 1879, had a value of this kind, quite apart from any positive legislation which it secured. The value of similar work done by certain railroad commissions can hardly be overestimated.
The worst abuses may be thus checked; but, as long as competition is at all active, there will be a good deal of local discrimination in favor of competitive points, which the common law is powerless to prevent. Against this system the so-called "short-haul" laws have been aimed. Probably no other point with regard to railroad regulation has been made the subject of so much discussion.
The short-haul principle provides that a railroad shall not charge a larger gross sum for a part of any route than it does for the whole—not more, for instance, from Chicago to Springfield, Massachusetts, than from Chicago to Boston. It is thus intended to prevent the more outrageous forms of local discrimination. There can be no doubt that as a general principle it is correct. But it is not one which it is always possible to enforce by law. If the law can reach all the rival routes, and can be enforced against all of them, it does much good and little or no harm. But, if it reaches one route and not another, it supply makes the other route a present of the through traffic. What, for instance, would be the effect of a national short-haul law on the movement of wheat from Chicago to the seaboard? At present, it is a traffic which the railroads can afford to make special efforts to secure, and they bring the rates down nearly to the level of operating expenses. If they reduced local rates to this basis, they would have nothing left to pay fixed charges. The only way by which they could comply with the law would be by raising through rates. This would simply have the effect of sending the wheat to Europe via Montreal instead of via American ports. The Grand Trunk Railroad, which would be outside of our control, would have the chance to make low through rates, and get the heavy through traffic. The English stockholders of the Grand Trunk would be the persons most benefited by such a law.
It is only a few years since the Prussian Government got into trouble in exactly this way. It was thought by the authorities that the low through rates favored the foreigners at the expense of the Germans; and an attempt was made to carry out the short-haul principle rigidly. The result simply was that the foreigners sent their goods by other routes which Bismarck was unable to control, and that the Prussian railroads lost a part of their traffic, which, low as were the rates charged upon it, was yet a matter of importance to their business prosperity.
Similar instances could be cited from almost any other country. Whenever we find a competitor which our law can not reach be it water-route, foreign railroad, or domestic railroad which violates the law in an underhand fashion the short-haul principle simply cripples the roads which obey it, without producing any corresponding good effect.
Experience has shown pretty clearly that local discrimination can be avoided only by bringing competition under control. The States where legal regulation of this matter has been most successful have been those like Georgia and Iowa, where the pooling system has been strongest and most stable, or those like Massachusetts, where competition has become, in local business, largely a thing of the past. Everywhere, in America and in Europe, periods of active competition have been periods of active discrimination. To check the second you must control the first. And the only practicable way of doing this, short of actual consolidation, is by a system of pooling. The mere agreement to maintain rates is not enough,; it is too easily violated by secret rebates. An agreement to divide the traffic or the earnings, as long as it holds at all, is much harder to violate secretly. This is what constitutes a "pool."
We are thus reduced to the simple alternative, pooling or discrimination. Each effort to prohibit both at the same time only makes the necessity more clear. The governments of Continental Europe have ceased to struggle against it. Rightly judging that discrimination is the main evil, they recognize pools as the most effective method of combating it. State roads enter into pooling contracts with private roads, railroads divide traffic with competing water-routes. The law, recognizing such contracts, is able to regulate them, and to deal with organizations of railroads better than it could deal with railroads individually.
In this respect they have the advantage over us in America. In our vain effort to prohibit pools altogether, we have simply intensified their worst features. By refusing to recognize them at all, we have rejected the chance to regulate them. We have done worse than this. By taking all permanent guarantees away from them, we have forced them to pursue a short-sighted policy. The prejudice against pools, as we have often seen them, is not an unreasonable one; but the fault is in the law quite as much as in the system. Admit, if you please (though it is by no means clear), that the disastrous multiplication of roads in 1882 was mainly due to the short-sighted manipulation of rates under the pooling systems: what then? Such short-sighted policy was an almost necessary result of a legal theory which refused to enforce pooling contracts, and made their continuance depend upon the voluntary adhesion of all parties. The pool was compelled to adopt a policy which should keep every one in good-humor for the day. The moment the directors of a single road were dissatisfied with present results, they could break the system down, regardless either of the rights of others or of their own permanent welfare.
No policy can be more suicidal than this. The temporary interests of the railroads often diverge widely from those of the community which they serve. Their permanent interests are almost identical. The sound and strong roads, with a permanent character to sustain, are much more likely to be managed in the public interest than roads on the verge of bankruptcy, whose only thought is for the present. Yet all our legislation is directed against roads of the former class. We place them at the mercy of reckless competition in the matter of rates. We allow the building of insolvent competitors by construction companies whose operations are no better than blackmail. We strive to limit their dividends, when the only practical results of such a measure will be diminution of enterprise and increase of extravagance. In our fear that the influence of railroad managers may become too great, we have devised laws which seriously interfere with their power for good, and leave their power for evil almost unchecked.
To this sweeping statement one important exception must be made. More by accident than by design, the railroad commissioners in a number of our States have become the representatives of the permanent interests of the railroads and community alike, against the short-sighted policy of extremists on either side. The history of the Massachusetts Commission has presented the most marked instance of what can be done in this way, by a body of men having no power except the power to secure publicity; it is perhaps the most encouraging example in recent history of the power of government by public opinion.
Whether a national commission could work successfully in this way is very doubtful. The public opinion of the nation as a whole is not so easily brought to bear in any one direction as is that of a single State. The national railroad system is too vast, the interests of different sections too conflicting. It is desirable that a national commission should be charged with the enforcement of certain specific provisions against discrimination. It would be a herculean task; but it is one which needs to be done, and one which we may feel reasonably sure that the courts could not even attempt to do.
On the other hand, it is desirable that the commission should not be a mere prosecuting body, but should depend for its force upon the influence of public opinion behind it. In this respect, the bill now before the United States Senate is a good one. It avoids alike the error of those who would give the commission no definite authority, and those who would charge it with doing what is actually impossible. The bill, as reported, rigidly prohibits personal discrimination, and generally prohibits local discrimination; but under this latter head it empowers the commission to make exceptions. It says nothing about pools; and, if this discreet silence is maintained, such a commission might readily use pools as a means of protecting the shipper against discrimination, instead of allowing them to be used solely for the purposes of the railroad investors and managers.
The great danger is, that the bill is too moderate to pass. In spite of all that has been said and written on railroad questions, the great majority of men are extremists on this subject. Some want an absolute let-alone policy; some want an energetic attempt at control which would really defeat its own ends. Both of these classes are opposed to a bill of this kind. The advocates of the let-alone policy are afraid that it would be enforced. The advocates of vigorous control are afraid that it would stand in the way of more decisive action. They feel—and not altogether without reason that the prolonged absence of national control may ultimately bring the question of government ownership in the foreground.
It must be remembered that a very considerable portion of the community believes in government railroad ownership, at least as an ideal. They perhaps exaggerate the evils of the present system, and certainly have the most unreasonable expectations of the good to be obtained from a change. It has been seriously argued with much show of figures, in a reputable working-men's paper, that it is possible to carry passengers from New York to San Francisco at a dollar apiece and make money on it, and that everything above this represents sheer extortion, which would be avoided by government ownership! Now, as long as these things are believed, their absurdity makes them none the less dangerous. In forecasting the future, we must reckon with the number of votes, and not simply with the value of the argument by which those votes have been influenced. Each year's failure to adopt any measure of national control probably increases the number of votes which would be cast in favor of government ownership.
It can not be denied that government ownership furnishes the best theoretical solution of the railroad problem, if we could only assume that the Government were possessed of infinite wisdom and virtue. But practically this condition is far from being realized in the United States. The question is a practical rather than a theoretical one. In countries like Germany, where the civil service represents the best elements of the nation, state railroads have been a success, simply because of that fact. Whatever system will give you the best administrative talent is likely to prove most successful. But it would be a bold thing to say that the best administrative talent of the United States found its way into the civil service, or was likely to do so for the present.
A state railroad system may be relied upon to do one thing—to check local discrimination. But this is not due so much to any considerations of public policy as to the complete monopoly which takes away all inducements to discriminate. Where a state road comes into conflict with private roads, it makes discriminations of the worst form. Where it has a monopoly, there is danger that it will avoid them by leveling up. The Italian investigating commission of 1878, after a careful comparison of the actual experience of different countries, came to the conclusion that state railroads did not, as a rule, do so much for industry as private railroads; that in general their rates were higher, their facilities worse, their responsibility less; that the state railroad management was more apt to tax business than to foster it; while political considerations were brought into matters of railroad construction and management in a way which was disastrous alike to railroads and to politics. It may be that these conclusions were in some respects overdrawn; but they are sufficient to show the wide difference between the popular ideal of state railroad management and the reality as seen in actual practice.
- In Mr. Lansing's valuable article on this subject ("Popular Science Monthly," February, 1886), the proportion is estimated considerably higher. Any argument on the reasons for the difference would be of too technical a character to come within the scope of this discussion.